Home equity loans can be a good option in many situations, but as with any loan, borrowers may face a dizzying array of fees. However, some costs may be avoided or reduced by shopping around, and some fees may be signs of abuse or outright fraud. In between are costs that can vary widely among lenders, local markets and even between the date of applying and closing the loan.
Many closing costs are unavoidable and vary little from market to market and among lenders.
Other costs are optional, and some can be reduced by shopping around.
Government has sought to curb abuses in home equity lending but some unscrupulous lenders may engage in abusive practices. Fortunately, there are clear red flags that may signal trouble for potential borrowers.
Emerging tech-based financial services products offer alternatives to borrowers who want to tap their home equity, but some may have hidden risks and drawbacks and may leave consumers less protected by the laws regarding more traditional loans.
Standard Fees Can Vary
Applications for home equity loans, as with first-mortgage loans, typically allow borrowers to lock in a rate when applying. However, if there are changes in circumstances, you may face a different rate. If the lender was unable to verify income, you may not be seen as able to afford the payback and could face a higher rate or a smaller loan amount.
If an appraisal of your home value comes in at less than expected, you may not qualify for the initial rate. You can ask for a reappraisal, but you will likely have to pay for it.
Home equity loans generally have a fixed interest rate, while HELOCs are more likely to have an adjustable rate. In such cases, know how your actual rate will be determined. Typically, the rate is tied to a common and widely published interest rate, such as U.S. Treasury bond rates, plus a proscribed margin. Finally, lenders may use discounted rates in their promotions, such as a quarter-point off for their credit card customers or for setting up automatic payments or for “qualified borrowers.”
Options Can Add Costs
Many home-loan costs are standard and predictable: Attorney’s fees, document-preparation fees, application fees, recording fees and taxes, escrow and insurance payments. But some may be shopped for, and others cover services that may not be necessary.
Title insurance guards against mistakes in titles and other paperwork recording a land transaction and is standard in home loans. Generally a borrower may shop for a better deal than what the lender’s preferred provider offers.
Credit insurance—which makes payments should you become unable to make them due to illness, disability or similar reason—may also be an optional add. Lenders are required to tell you if they require it. If you do not need it and don’t want it, ask for it to be removed.
For much of the last decade, interest rates have been incredibly low but this era appears to be ending as the Federal Reserve has increased interest rates multiple times so far in 2022. Home equity loans still carried risks, but were relatively cheap with low payments. As interest rates rise, borrowing against your home’s equity means larger payments that may be harder to accommodate if your income decreases.
A federal case brought in 1999 at the apparent height of sub-prime lending targeted abusive practices, primarily lending to people who could not afford it and charging high rates and adding expensive fees. Much of the case involved asset-based lending, in which lenders made loans sized on the value of the homes involved, rather than the borrower’s ability to pay. Changes in the federal law, particularly the Home Ownership and Equity Protection Act—an amendment to TILA, the Truth in Lending Act—and subsequent legislation sought to stop the practice.
The Home Ownership and Equity Protection law attempts to rein in predatory lending practices. Some of its protections include: banning many prepayment penalties; balloon payments due in fewer than five years on high-rate, high-fee loans; and increasing the interest rate in case of default.
Balloon payments in most cases. Exceptions are for borrowers with sporadic income or in certain rural or underserved areas.
Late fees more than 4% of your regular payment
Fees for getting statements on how much you owe, aka a payoff statement
Fees for loan modifications, except under certain circumstances
Is There Any Negotiation Room in the Fees?
Many of the fees a lender tries to charge aren’t set in stone. Some lenders may be willing to bend on origination fees, which cover the commission paid to the loan officer or broker. If they require you to pay points on your loan, they may be willing to haggle on that, too. But you have to ask.
How Important Is My Credit Score?
In general, you’ll get the best terms if you have a history of steady employment and an excellent credit score. As with any mortgage application, it’s a good idea to check your credit reports ahead of time and make sure they’re free of errors. For this reason, it may also be worth considering employing a credit monitoring service as a means of keeping this information safe.
Do All Home Equity Loans Have Fees?
No. Some home equity loans have no fees. Some lenders charge different fees depending on the amount of the home equity loan, and some have zero fees for any home equity loans. As with any loan product, shop around to make sure you’re getting the best deal.
Is a Home Equity Loan Safer than a HELOC?
Home equity loans and home equity lines of credit (HELOCs) both use your home’s equity as collateral and carry the same risk of losing your home to foreclosure if you can’t pay them back. Where they differ is in their interest rates. A home equity loan has a fixed interest rate, while a HELOC usually has a variable interest rate. Because of this, a home equity loan can be safer than a HELOC if your HELOC has a high balance. With a HELOC, there’s an additional risk that rates could rise to the point that you can’t afford your monthly payment. With a home equity loan, your rate and payment remain fixed.
The Bottom Line
Home equity loans can be a good way to use home equity for financially sound purposes, but as with all borrowing, it pays to be educated about fees and the real costs of taking out the loan. Scrutinize the costs and shop around for the best rates you can find.